Europe and Central Asia (ECA) were seriously impacted by the Global Financial Trouble (GFC). However, there were many fault lines that triggered the GFC, insufficient capital of banks to pay for unpredicted losses led to greater spillovers in to the real economy, which made the economic crisis a lot more severe. As a direct consequence from the GFC, several ECA countries have introduced legislation and regulatory reforms to bolster capital needs. These reforms include growing regulatory capital needs in addition to alterations in what constitutes the main city instruments from the greatest quality (when it comes to loss absorption).
Inside a recent policy paper, we evaluate the evolution of bank capital and capital rules in ECA using data from the newest Bank Regulation and Supervision Survey (BRSS) conducted through the World Bank (Anginer et al. 2019). We show three important developments in the last decade.
First, ten years following the crisis, banks within the ECA region be more effective capitalized, as measured by their regulatory capital ratios, calculated as regulatory capital divided by risk-weighted assets. Figure 1 shows alterations in the regulatory capital ratios for subregions in ECA. Although there’s variation across countries, overall there’s been a rise in regulatory capital ratios, specifically for bigger banks. Excluding EU countries, typically in ECA, regulatory capital elevated 5 percentage points between 2007 and 2017.
FIGURE 1. Regulatory Capital over RWA
Figure 1. Regulatory capital over RWA
Source: Anginer, Demirgüç-Kunt, and Mare 2020.
Note: EU = The European Union, Southern Europe, and Northern Europe CE & BC = Central Europe & Baltic countries WB = Western Balkans SC = South Caucasus CA = Central Asia EE = Eastern Europe ROW = world RWA = risk-weighted assets. We report means weighted by bank size.
Second, increases in simple leverage ratios, measured as common equity divided by total assets, happen to be more limited. Figure 2 shows alterations in the straightforward leverage ratios for subregions in ECA. Generally, through the finish of 2017, smaller sized banks held more capital (like a number of total assets) than their bigger counterparts did, with the exception of Central Europe and also the Baltic countries, Poultry, and Western Balkans. Different color leaves, through the finish of 2017, there seems to possess been typically a large gap between your leverage ratios of small banks and enormous banks, mainly in the Spain, Eastern Europe, and South Caucasus. Overall, simple leverage ratios elevated 1.3 percentage points between 2007 and 2017, excluding ECA EU countries.
FIGURE 2. Capital over Total Assets
Figure 2. Capital over Total Assets (%) – top 20% banks and bottom 80%
Source: Anginer, Demirgüç-Kunt, and Mare 2020.
Note: EU = The European Union, Southern Europe, and Northern Europe CE & BC = Central Europe & Baltic countries WB = Western Balkans SC = South Caucasus CA = Central Asia EE = Eastern Europe. We report means weighted by bank size.
Third, the increases in regulatory capital ratios coincided with a decrease in Tier 1 stringency and decrease in risk weights. The phrase the main city factors that constitute Tier 1 capital is becoming less stringent within the ECA region. Similarly, the number of risk-weighted assets to total assets has declined. Figure 3 shows the alterations within an index that captures the stringency from the Tier 1 capital definition. Overall, in the majority of the ECA subregions, the phrase Tier 1 capital was less stringent in 2016 compared to 2010, aside from the Western Balkans, South Caucasus, and Russia.
FIGURE 3. Tier 1 Stringency Index
Figure 3. Tier 1 Stringency Index
Source: Anginer, Demirgüç-Kunt, and Mare 2020.
Note: EU = The European Union, Southern Europe, and Northern Europe CE & BC = Central Europe & Baltic countries WB = Western Balkans SC = South Caucasus CA = Central Asia EE = Eastern Europe ROW = world.
Since capital functions like a buffer against unforseen losses, the caliber of capital is essential in figuring out the solvency of the bank. Lower quality capital, that’s, capital instruments apart from common equity, could be considerably undervalued during occasions of distress, reducing their effectiveness in serving as a cushion against shocks. Risk exposures will also be hard to estimate, and current rules provide substantial discretion to banks in figuring out risk weights. Thus, banks can manipulate the danger weights to satisfy regulatory needs or concoct their capital positions.
Within the paper, we reveal that bank risk in ECA is much more responsive to alterations in simple leverage ratios than to regulatory capital ratios. It is because the numerator only includes equity capital and also the denominator is really a way of measuring exposure that doesn’t depend on risk weights.
Overall, there’s been progress in the area in strengthening capital rules. Whether regulatory capital turns out to be sufficient within the next crisis is determined by the precision from the risk weights in truly recording forward-searching risk as well as on losing-absorbing capacity from the lower quality capital that’s now permitted within the computation of Tier 1 regulatory capital.
Reported references
Anginer, D., Bertay, A. C., Cull, R., Demirgüç-Kunt, A., & Mare, D. S. (2019). Bank Regulation and Supervision 10 Years following the Global Financial Trouble. Policy Research Working Paper 9044, World Bank, Washington, Electricity.
Anginer, D., Demirgüç-Kunt, A., & Mare, D. S. (2020). Bank Capital and Risk in Europe and Central Asia 10 Years Following the Crisis. Policy Research Working Paper 9138, World Bank, Washington, Electricity.